We study the impact of China’s 2013 implementation of Basel III on bank risk-taking and its responses to monetary policy shocks using confidential loan-level data from a large Chinese bank. Guided by theory, we use a difference-in-differences (DiD) identification, exploiting cross-sectional differences in lending behaviors between high-risk and low-risk bank branches before and after the new regulations. We identify a novel risk-weighting channel through which changes in regulations significantly reduced bank risk-taking, both on average and conditional on monetary policy easing. However, bank branches reduce risk-taking by increasing lending to ostensibly low-risk state-owned enterprises (SOEs) under government guarantees, despite their low average productivity. Our findings suggest that, under prevailing policies that favor SOEs, China’s monetary policy faces a tradeoff between bank risk-taking and credit misallocation.
Li, Xiaoming, Yuchao Peng, Zheng Liu, and Zhiwei Xu. 2020. “Bank Risk-Taking, Credit Allocation, and Monetary Policy Transmission: Evidence from China,” Federal Reserve Bank of San Francisco Working Paper 2020-27. Available at https://doi.org/10.24148/wp2020-27